Alibaba allocates to happy few

It was a case of open sesame for Alibaba's IPO investors, with the company making a strong debut on the New York Stock Exchange after significantly scaling back allocations in its $320 billion order book.

There has never been another IPO like it and once Alibaba exercises its greenshoe, the company is set to enter the record books with the largest and one of the most successful and symbolic flotations in history. At $25.03 billion (post shoe), the e-commerce giant's deal will easily sweep past the previous record holder, Agricultural Bank of China, which raised $22.1 billion through its IPO in 2010.

As expected, the offering was priced at the top of a revised price range after the New York close on Thursday, with 320.1 million ADS units issued at $68 each. The greenshoe constitutes a further 48 million units and will bring the issued share capital up to 14.1%.

The leads have already placed out the shoe and have 30 days to formally exercise it. However, indications suggest this could happen within the first few days of trading.

Over the past few weeks, demand and hype have gone hand in hand, pushing the order book up to around $320 billion. Retail demand came in at $35 billion, higher than Facebook achieved in 2012 and putting paid to speculation that Alibaba had less brand awareness among them.

Unsurprisingly, there was a huge degree of order inflation particularly from funds, which had not been among the 60 large global accounts selected to complete pre-roadshow due diligence work.

As a result, the syndicate opted to close the deal early to manage the flow and adopt a very tight allocation policy. Close to 1,800 institutions applied for stock overall, but about 50% received no allocation and of those funds, which were allocated, half again received less than $1 million.

In total, the top 50 investors received 80% of the deal and US funds received about 85% of the institutional allocation, meaning Asian and European accounts received relatively little. US retail investors were allocated about $1 billion, a large amount in dollar terms, but small relative to the overall size of the deal.

"Alibaba was very very involved in the allocation process," one observer reported. "This was driven by them and not the syndicate. They actively chose the institutional partners they wanted to work with."

"And they wanted to target US accounts because they see themselves as a global company, which just happens to be based in Asia," he added. "They had already done a pre-IPO convertible preference share deal, which mainly went to Asian accounts so this re-dressed the balance."

And those Asian accounts, which did receive stock from the IPO, are largely those, which also participated in the convertible preference share deal, although there are a couple of new accounts.

Trying to ensure paper stays locked up by placing it with long-only accounts is always a sensible move for a super-jumbo offering such as this. In Alibaba's case, there was also a 6% allocation to friends and family, many of whom might have opted to book profits sooner rather than later. 

On top of this, there were a further 128.4 million shares held by pre-IPO investors, which are not subject to any kind of lock-up and could flow into the secondary market.

However, Alibaba nevertheless made an extremely strong debut when it opened for trading thanks to the liquidity squeeze, plus the sheer scale of unsatisfied demand. After opening at $92.70, the stock traded up to a high just short of $100, before closing the day at $93.89, up 38%

A lot of follow-through demand had been expected from Asian-based institutional and retail investors active on the Hong Kong Stock Exchange where the company initially hoped to list. Demand levels from previous Hong Kong jumbo offerings offer a guide to how eager they may prove to be over the coming few days.

The figures also demonstrate that while demand for Alibaba has been staggering, it still cannot quite compare to the frenzy popular Hong Kong IPOs have attracted in the past.

In 2006, for example,China's largest bank, ICBC, raised $21.9 billion from what is still the third-largest IPO on record. In doing so, it recorded more than $440 billion of demand, of which retail accounted for $55 billion.

Likewise, Alibaba's IPO of its B2B portal in 2007 smashed a number of records including the highest valuation on record (53.8 times forward earnings) and the highest level of retail subscription by dollar amount ($58 billion). Despite the extremely punchy valuation, sheer momentum pushed the deal up 192% during its first day's trading.

But the company learnt a number of lessons from its initial stock market foray, which it has applied to the current offering. First and foremost, it has not pushed for an overly aggressive valuation, which subsequent earnings growth may fail to deliver.

For having priced Alibaba.com at HK$13.50 per share in 2007, the parent ended up taking the company private at the same level five years later. Short-term hype did not lead to long-term shareholder value, with the stock plunging after a change in business strategy prompted a loss of vendors and earnings downgrades.

Potential upside

So just how high could Alibaba go? First day's trading shows that it has already surpassed ICBC's first day performance of 14.6%, which means that Alibaba is now bigger than ICBC in terms of market capitalization.

From an initial market capitalization of $179.2 billion (post shoe), the stock is currently valued at $247.3 billion compared to ICBC's $210.7 billion.

It also outperformed the first day's trading performance of the largest domestic US IPO on record, Visa, which raised $19.7 billion in March 2008 and rose 28% on its debut. Its share price has quintupled in the six years since then.

The one stock Alibaba was hoping not to emulate was Facebook, whose $18.4 billion IPO in 2012 was assailed by trading glitches and controversy over a revenue update published just before trading began. But Alibaba has now surpassed Facebook's $199 billion market capitalization, making it the fourth largest tech company in the world behind Microsoft, Google and Apple.

It is also now the second-largest listed Chinese company behind China Mobile, having overtaken Petrochina, which has a current market cap of $237 billion. If the hype continues on Monday, it could also surpass China's largest telecom company, which is currently valued at $250 billion.

At $68 per ADR, Alibaba was priced at 27.3 times forecast 2015 earnings, but is now trading at 37.67 times. This places the stock at a significant premium to its nearest benchmark, Tencent Holdings, trading at 27.5 times 2015 earnings. 

Tencent has been on a downtrend since the middle of August, falling 6.3% to its $16.02 close on Friday. This poor performance may have been partly due to investors positioning themselves in readiness for Alibaba.

Other benchmarks have similarly come under selling pressure. China's second e-commerce operator, JD.com, has lost 13.5% since August 27. The stock re-bounded 5.16% on Thursday, only to fall another 4.06% on Friday.

China's largest search engine Baidu has followed a similar pattern, falling since September 3, only to re-coup most of those losses Thursday, when it rose 4.28% on the day. It also rose 1.54% on Friday and is currently trading at 26.4 times 2015 earnings.

Where US comparables are concerned, eBay (Alibaba's rival to Taobao) has been on a downtrend since August 26, falling 6.5% and is currently trading at 14.4 times 2015 earnings. It rose 1.44% Thursday, then fell 0.57% on Friday.

Amazon (Alibaba's rival to Tmall) has also been falling since September 4 and cannot really be compared on a p/e basis since it is presently loss-making.

Changeable market conditions

But Alibaba-induced selling pressure is only part of the picture. Market conditions were also against all Asian stocks last week. When roadshows began on September 8, markets were still on a post summer uptrend. Since then the Hang Seng Enterprises Index has fallen 5.5%.

This has been driven by two sets of poor numbers from China, beginning with weak factory output last weekend, followed by a fourth consecutive monthly drop in house price sales on Wednesday. Together, these two factors overrode equity investors' relief that the US Federal Reserve did not change its accommodative stance on Wednesday. 

Two stocks, which have performed well, giving another foretaste into Alibaba's performance, are Yahoo and Softbank. Both have been heavily utilised as proxies for Alibaba given their respective shareholdings in the company.

Yahoo has been on a new uptrend since July 18, rising 12.2% to $42.08, although it was down 1.19% on Thursday and a further 2.74% on Friday.

Softbank is up an even more impressive 12.37% since August 8, although it too was down 0.83% on Friday.

Alibaba as the ultimate China proxy

Founder Jack Ma and his management are team likely to be ecstatic at global investors' reception to their company. For many, Alibaba's IPO represents a coming of age for Chinese listings in the US, in tandem with the country's growing international presence.

Alibaba controls 80% of China's e-commerce market, but as the roadshow team made clear, the company views this as merely a beginning given the underpenetration of online shopping relative to the country's enormous population. Alongside Tencent and Baidu, Alibaba is also looking towards the next technological frontier - securing consumers' mobile wallets by taking on the domestic banking sector. 

Alibaba also has ambitions to go global, which will put it into closer competition with Amazon and also eBay, which Jack Ma once described as the shark in the ocean to his crocodile in the Yangtze.

But in his recent letter to prospective shareholders, Ma seems to have changed tack, portraying Alibaba as the small company’s friend. “We fight for the little guy,” he declared. “Since our founding in 1999, we have helped millions of small businesses to achieve a brighter future."

But Alibaba’s recent acquisition spree shows that it is also very good at hovering them up in its bid to extend and consolidate its hold over the China’s digital eco-system. Perhaps these days Alibaba is less of a crocodile and more of a blue whale, mouth wide open, swallowing up every small fish in sight.

How this very large fish is able to monetise these acquisitions and continue delivering shareholder value on its core businesses will ultimately determine whether Alibaba can achieve one of Jack Ma's stated ambitions - matching American consumer and tech titans Wal-Mart and Microsoft in the public's consciousness.

The success of its US listing shows it has already taken a very large step in that direction.

This story was updated after first publication.

 

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